Eric Tyson Investing in Your 20s & 30s For Dummies For Dummies (2012) pdf pdf
Investing in Your 20s & 30s For Dummies ®
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Developing and Testing Your Investing Beliefs
What are your investing beliefs? Most investors haven’t taken the time to consider that question, let alone to answer it. During the sharp stock market slide in 2008, some investors started following particular gurus who claimed to have predicted the financial crisis. These investors wanted to believe that someone out there could predict important financial events and tell folks how to time their investments to benefit from what was about to unfold. Such market timing is a fool’s errand. It sounds possible, and we’d like to believe that it is possible, but it’s not possible on the scale various charlatans would have you believe. As a reader of this book, you probably have a better idea of your investment beliefs than most investors do. To help you along in this process, here are some beliefs for you to consider:
Your own personal comfort matters. A wide range of investments are available to you, including stocks, exchange-traded funds (ETFs), mutual funds, real estate, and small business. Some folks are simply more comfortable with particular investments, so you shouldn’t force yourself into a portfolio that’s recommended as being best for you. Consider the value of your time and your investing skills and desires. Investing in stocks and other securities via the best mutual funds and ETFs is both time-efficient and profitable. Real estate investing and running a small business are the most time-intensive investments. Costs matter. The more you pay in commissions and management fees on your investments, the greater the drag on your returns. And don’t fall prey to thinking that you get what you pay for. Take advantage of tax-deductible retirement accounts, and understand the effect of your tax bracket when investing outside tax-sheltered retirement accounts. Minimize your trading. The more you trade, the more likely you are to make mistakes. Also, you suffer increased transaction costs and higher taxes for non-retirement-account investments.
Market timing is much harder to predict than folks realize. Don’t bail when things look bleak. The hardest time, psychologically, to hold on to your investments is when they’re down. Even the best investments go through depressed periods, which is the worst possible time to sell. Don’t sell when there’s a sale going on; if anything, consider buying more. Ignore soothsayers and prognosticators. Predicting the future is nearly impossible. There are better times than others to sell. When you’re really feeling good about an asset class like stocks, and those assets have had a multiple-year run and are getting widespread accolades, that’s a good time to lighten up if you have other good reasons for doing so. By holding more-aggressive investments. Diversifying simply means that you hold a variety of investments that don’t move in tandem in different market environments. When investing in stocks, for example, invest worldwide. You can diversify further by investing in real estate.
Emphasize value. Over the long term, value-oriented investments tend to produce higher returns with less volatility than do pure growth-oriented investments. Ignore the minutiae. Don’t feel mystified by or feel the need to follow the short-term gyrations of the financial markets. Ultimately, the prices of stocks, bonds, and other financial instruments are determined by supply and demand, which are influenced by thousands of external issues, including millions of investors’ expectations and fears. You are what you read and listen to. Don’t pollute your mind with bad investing strategies and philosophies. The quality of what you read and listen to is far more important than the quantity.
Praise for Eric Tyson
“Eric Tyson For President!!! Thanks for such a wonderful guide. With a clear, no-nonsense approach to . . . investing for the long haul, Tyson’s book says it all without being the least bit long-winded. Pick up a copy today. It’ll be your wisest investment ever!!!” — Jim Beggs, VA “Eric Tyson is doing something important — namely, helping people at all income levels to take control of their financial futures. This book is a natural outgrowth of Tyson’s vision that he has nurtured for years. Like Henry Ford, he wants to make something that was previously accessible only to the wealthy accessible to middle-income Americans.” — James C. Collins, coauthor of the national bestsellers Built to Last and Good to Great “Among my favorite financial guides are . . . Eric Tyson’s Personal Finance For Dummies.” — Jonathan Clements, The Wall Street Journal “In Investing For Dummies, Tyson handily dispatches both the basics . . . and the more complicated.” do or consider doing without explaining the why’s and how’s — and the booby traps to avoid — in plain English. . . . It will lead you through the thickets of your own finances as painlessly as I can imagine.” — Clarence Peterson, Chicago Tribune “Personal Finance For Dummies is the perfect book for people who feel guilty about inadequately managing their money but are intimidated by all of the publications out there. It’s a painless way to learn how to take control.” — Karen Tofte, producer, National Public Radio’s Sound Money
More Best-Selling For Dummies Titles by Eric Tyson ® Personal Finance in Your 20s For Dummies
This hands-on, friendly guide provides you with the targeted financial advice you need to establish firm financial footing in your 20s and to secure your finances for years to come. When it comes to protecting your financial future, starting sooner rather than later is the smartest thing you can do. Also check out Personal Finance For Dummies.
® Mutual Funds For Dummies This best-selling guide is now updated to include current fund and portfolio recommendations.
Using the practical tips and techniques, you’ll design a mutual fund investment plan suited for your income, lifestyle, and risk preferences.
® Home Buying For Dummies
America’s No. 1 real estate book includes coverage of online resources in addition to sound financial advice from Eric Tyson and front-line real estate insights from industry veteran Ray Brown. Also available from America’s best-selling real estate team of Tyson and Brown — House Selling For Dummies and Mortgages For Dummies.
® Real Estate Investing For Dummies enterprising guide. From drafting a business plan to managing costs, you’ll profit from expert advice and real-world examples that cover every aspect of building your own business.
® Investing in Your 20s & 30s For Dummies by Eric Tyson, MBA ® Investing in Your 20s & 30s For Dummies
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About the Author
Eric first invested in mutual funds back in the mid-1970s, when he opened a mutual fund account at Fidelity. With the assistance of Dr. Martin Zweig, a now-famous investment market analyst, Eric won his high school’s science fair in 1976 for a project on what influences the stock market. In addition to investing in securities over the decades, Eric has successfully invested in real estate and started and managed his own business. He has counseled thousands of clients on a variety of investment quandaries and questions.
He earned a bachelor’s degree in economics at Yale and an MBA at the Stanford Graduate School of Business. Despite these impediments to lucid reasoning, he came to his senses and decided that life was too short to spend it working long hours and waiting in airports for the benefit of larger companies.
An accomplished freelance personal finance writer, Eric is the author of numerous best-selling books, including For Dummies books on personal finance, investing, mutual funds, and home buying (co-author), and is a syndicated columnist. His work has been featured and quoted in hundreds of national and local publications, including Kiplinger’s Personal Finance Magazine,
Los Angeles Times, Chicago Tribune, The Wall Street Journal, and Bottom Line/Personal, and
on NBC’s Today Show, ABC, CNBC, PBS’s Nightly Business Report, FOX, CNN, CBS national radio, Bloomberg Business Radio, National Public Radio, and Business Radio Network. He’s also been a featured speaker at a White House conference on retirement planning. You can visit him on the web at
Dedication Actually, before I get to the thank yous, please allow me a really major thank you and dedication.
This book is hereby and irrevocably dedicated to my family and friends, as well as to my former students, counseling clients, and customers, who ultimately taught me everything I know about how to explain financial terms and strategies so that all of us may benefit.
Author’s Acknowledgments
First, I’d like to thank Elizabeth Rea. Thanks also to Kathy Simpson for all of her fine editing and to all of the fine folks in Composition and Graphics for making this book look great! Thanks also comments, please contact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax 317-572-4002.
Some of the people who helped bring this book to market include the following:
Acquisitions, Editorial, and Vertical Websites Project Editor: Elizabeth Rea Acquisitions Editor: Erin Calligan Mooney Copy Editor: Kathy Simpson Assistant Editor: David Lutton Editorial Program Coordinator: Joe Niesen Technical Editors: Gary Karz, CFA; John L. Nelson, CFA Editorial Manager: Michelle Hacker Editorial Assistant: Alexa Koschier Cover Photos: © iStockphoto.com/vova Kalina, © iStockphoto.com/pictafolio Cartoons: Rich Tennant Composition Services Project Coordinator: Kristie Rees Layout and Graphics: Jennifer Creasey, Joyce Haughey, Laura Westhuis Proofreaders: Cynthia Fields, Lauren Mandelbaum Indexer: Dakota Indexing Publishing and Editorial for Consumer Dummies
Andy Cummings, Vice President and Publisher
Composition ServicesDebbie Stailey, Director of Composition Services
Introduction
Investing offers so many possibilities and so many choices. Your young adult years, which at least for the purposes of this book I define as your 20s and 30s, are filled with so much promise and potential. Your career, your interests, your personal life, and your family and friends all compete for your time and attention. Most folks work upward of 2,000 hours per year earning a living. Managing the money that passes through their hands is an important task, which most folks aren’t trained to do.
Earning money generally takes a lot of work. Managing your personal finances and saving money take discipline and sacrifice. When you have money to invest, you want to do the best that you can so that you earn a decent return without ending up in failed investments.
About This Book I designed and wrote this book to help you with the important and challenging task of investing
Your young adult years are a great time to lay the best foundation for investing wisely. After all, some of the investments you make now and in the near future will have decades to grow and multiply. I’ve worked with and taught people from all financial situations, so I know the investing concerns and questions of real folks just like you. I’ve discovered how important having healthy and strong personal finances and investments is. I first became interested in money matters as a middle-school student when my father was laid off and received some retirement money. I worked with my dad to make investing decisions with the money. A couple of years later, I won my high school’s science fair with a project on what influences the stock market.
During my younger adult years, I worked hard to keep my living expenses low and to save and invest money so that I could leave my job and pursue my entrepreneurial ideas. I accomplished that goal in my late 20s. I hope to give you some tools to help you make the most of your money and investments so you too can meet your goals and dreams.
I put all web addresses in monofont for easy identification.
What You’re Not to Read
I’ve written this book so you can find information easily and easily understand what you find. And although I’d like to believe that you want to pore over every last word between the two yellow- and-black covers, I actually make it easy for you to identify “skippable” material. The sidebars are the shaded boxes that appear here and there. They include helpful information and observations that, while interesting, aren’t essential for you to know.
Foolish Assumptions
No matter what your current situation is — whether you’re entering the job market right after high school, graduating college with a large amount of student loans, pretty well established in your career, and so on — I thought of you as I wrote this book and made some assumptions about you:
You want expert advice about important investing topics such as getting a preinvesting financial checkup, understanding the range of investments available, and assembling a killer investment portfolio. And you want that advice quickly. You want a crash course in investing and are looking for a book you can read cover to cover to help solidify major concepts and get you thinking about your investments in a more comprehensive way. You’re tired of feeling overwhelmed by your investing choices and stressed out by the ever- changing economic and investing landscape, and you want to get more comfortable with your investment selections. This book is basic enough to help a novice get his or her arms around thorny investing issues. But advanced readers will be challenged as well to think about their investments and finances in a new way and identify areas for improvement. Check out the table of contents for a chapter-by-chapter rundown of what this book offers. You can also look up a specific topic in the index. Or you can turn a few pages and start at the beginning: Chapter 1.
How This Book Is Organized Investing in Your 20s and 30s For Dummies is organized into five parts, with each covering a reasonable returns to expect from various investments, how those returns compound over time, how taxes work on investments, and what you can do to minimize your investment taxes.
Part II: Preparing Your Investing Foundation In this part, I explain how your financial plans should translate into your investing plans and what
financial housekeeping you should do before investing. I also explain what role bank and credit union accounts can play in your investment portfolio and what alternatives can make you more money. Finally, I discuss money market mutual funds and how to select the right one for your situation.
Part III: Beginning Investments You don’t already have to be rich to tap into the best investments! In this part, I explain how stocks
and bonds work and how to make money in them. I also cover fund investing — specifically, investing in mutual funds and exchange-traded funds. I discuss how to match funds to your objectives, how to create and manage a fund portfolio, and how to choose among alternatives to funds.
Part IV: Advanced Investments This part covers more advanced and complicated investments that you should consider. I start with
real estate, which not only could include a home in which you live, but also investment property you would rent out. Then I move on to small-business investing, which can include starting your own company, buying a company, and possibly investing in someone else’s company. I close by discussing some other investments, including annuities, insurance, collectibles, gold, and other commodities.
Part V: The Part of Tens In this part, I present some lists of ten-somethings that can help you with your finances. The topics
covered are the ten things you need to know about information resources and the ten principles of investing success.
Icons Used in This Book
This icon points out information that you’ll definitely want to remember.
This icon marks things to avoid and points out common mistakes people make when making and managing their investments.
This icon alerts you to scams and scoundrels who prey on the unsuspecting.
This icon tells you when you should consider doing some additional research. Don’t worry — I explain what to look for and what to look out for.
Where to Go from Here
This book is organized so you can go wherever you want to find complete information. You can use the table of contents to find broad categories of information or the index to look up more specific topics. If you’re not sure where you want to go, you may want to start with Part I. It gives you all the basic info you need to assess your financial and investing situation and points to places where you can find more detailed information for improving it.
Part I
Understanding Investing Terms and Concepts In this part.
I cover conceptual material starting with defining commonly used investing jargon, including explaining the different types of investments, along with their expected returns and risks. I also delve into how to use investments to accomplish your goals, such as making larger purchases, buying a home, and investing for retirement. Lastly, I discuss how investment returns are taxed and
Making Sense of Your Investing Options
In This Chapter
Common investments and how they compare Investment terminology explained — risks and returns The gobbledygook of professionals, credentials, and investment companies
So many fields and disciplines are packed full of jargon. Some of this is the result of “progress” and advances, and some of it is caused by workers in the field not going out of their way enough to explain and define things. In this chapter, I give you the lay of the land regarding the enormous numbers of choices and foreign-sounding terminology that await you in the world of investing. I also explain the types of companies that offer investments and their strengths and weaknesses. And should you want to hire some investing help, I also detail the various professionals pitching their services to you and the common credentials they hawk to convince you of their expertise.
Growing Your Money in Ownership Investments
The most exciting thing about investing during your younger adult years is that you can be more aggressive with money that you’ve earmarked to help you accomplish long-term goals. To achieve typical longer-term financial goals, such as retiring, the money that you save and invest generally needs to grow at a rate much faster than the rate of inflation. If you put your money in a bank account that pays little or no interest, for example, you’re likely to fall short of your goals. Ownership investments are investments like stocks, where you own a piece of a company, real estate, or a small business that has the capability to generate revenue and profits. Over the long term, consider ownership investments if you want your money to grow much faster than the rate of inflation and don’t mind more volatility in your investments’ values.
The downside to such investments is that they can fall more significantly in value than non- ownership investments, especially in the short term. So don’t put money into ownership
If you want the potential to share in the growth and profits of companies, you can gain it through buying shares of their stock. Stocks are shares of ownership in a company. You can buy stock directly in individual companies through a brokerage account, or you can buy a collection of stocks via a mutual fund or exchange-traded fund (see Chapter 10).
You don’t need to be a business genius to make money in stocks. Simply make regular and systematic investments, and invest in proven companies and funds while minimizing your investment expenses and taxes. Of course, there’s no guarantee that every stock or stock fund that you buy will increase in value. In Chapter 8, I explain proven and time-tested methods for making money in stocks.
Profiting from real estate
You don’t need to be a high roller to make money investing in real estate. Owning and managing real estate is like running a small business: You need to satisfy customers (tenants), manage your costs, keep an eye on the competition, and so on. Some methods of real estate investing require more time than others, but many are proven ways to build wealth.
Among the key attributes of real estate investment are the following: You build wealth through your rental income exceeding your expenses and through property- value appreciation.
You can leverage your investment by borrowing money. You must be comfortable dealing with property management, which includes finding and retaining tenants and keeping up (and possibly improving) your property.
See Chapter 11 for the details on investing in real estate.
Succeeding in small business
I know people who have hit investing home runs by owning or buying businesses. Most people work full-time at running their businesses, increasing their chances of doing something big financially with them. Investing in the stock market, by contrast, tends to be more part-time in world through buying an existing business or investing in someone else’s budding enterprise. See Chapter 12 for more details.
Keeping Money in Lending Investments
In the first section of this chapter, “Growing Your Money in Ownership Investments,” I discuss how you can make your dough grow much faster than the cost of living by using stocks, real estate, and small business. However, you may want or need to play it safer when investing money for shorter-term purposes, so you should then consider lending investments. Many people use such investments through local banks, such as in a checking account, savings account, or certificate of deposit. In all these cases with a bank, you’re lending your money to the bank.
Another lending investment is bonds. When you purchase a bond that has been issued by the government or a company, you agree to lend your money for a predetermined period of time and receive a particular rate of interest. A corporate bond may pay you 4 percent interest over the next three years, for example.
An investor’s return from lending investments is typically limited to the original investment plus interest payments. If you lend your money to a company through one of its bonds that matures in, say, five years, and the firm doubles its revenue and profits over that period, you won’t share in its growth. The company’s stockholders reap the rewards of the company’s success, but as a bondholder, you don’t. You simply get interest and the face value of the bond back at maturity. Similar to bank savings accounts, money market mutual funds are another type of lending investment. Money market mutual funds generally invest in ultra-safe things such as short-term bank certificates of deposit, U.S. government–issued Treasury bills, and commercial paper (short- term bonds) that the most creditworthy corporations issue.
Many people keep too much of their money in lending investments, thus allowing others to reap the rewards of economic growth. Although lending investments appear safer because you know in advance what return you’ll receive, they aren’t that safe. The long-term risk of these seemingly safe money investments is that your money will grow too slowly to enable you to accomplish your personal financial goals. In the worst cases, the company or other institution to which you’re lending money can go under and fail to repay your loan.
Understanding risks
The investments that you expect to produce higher returns fluctuate more in value, particularly in the short term. However, if you attempt to avoid all the risks involved in investing, you likely won’t succeed, and you likely won’t be happy with your investment results and lifestyle. In the investment world, some people don’t go near stocks or real estate that they perceive to be volatile, for example. As a result, such investors often end up with lousy long-term returns and expose themselves to some high risks that they overlooked, such as the risk of inflation and taxes eroding the purchasing power of their money. You can’t live without taking risks. Risk-free activities or ways of living don’t exist. You can sensibly minimize risks, but you can never eliminate them. Some methods of risk reduction aren’t palatable because they reduce your quality of life. Risks are also composed of several factors. Following are the major types of investment risks and a few of the methods you can use to reduce these risks while not missing out on the upside that investments offer:
Market-value risk: Although stocks can help you build wealth, they can also drop 20 percent or more in a relatively short period of time. Although real estate, like stocks, has been a rewarding long-term investment, various real estate markets get clobbered from time to time.
Individual-investment risk: A down market can put an entire investment market on a roller- coaster ride, but healthy markets also have their share of individual losers. Just as individual stock prices can plummet, so can individual real estate property prices. Purchasing-power risk: Inflation — which is an increase in the cost of living — can erode the value of your money and its purchasing power (what you can buy with that money). I often see skittish investors keep their money in bonds and money market accounts, thinking that they’re playing it safe. The risk in this strategy is that your money won’t grow enough over the years for you to accomplish your financial goals. In other words, the lower the return you earn, the more you need to save to reach a financial goal. As a younger investor, you need to pay the most attention to the risk of generating low returns because your money will be invested over so many years and decades.
Career risk: In your 20s and 30s, your ability to earn money is probably your biggest asset.
Education is a lifelong process. If you don’t continually invest in your education, you risk losing your competitive edge. Your skills and perspectives can become dated and obsolete. Although that doesn’t mean you should work 80 hours a week and never do anything fun, it does mean that part of your “work” time should involve upgrading your skills.
Managing risks
Throughout this book as I discuss various investments, I explain how to get the most out of each one. Because I’ve introduced the important issue of risk in this chapter, I would be remiss if I also didn’t give you some early ideas about how to minimize those risks. Here are some simple steps you can take to lower the risk of investments that can upset the achievement of your goals:
Do your homework. When you purchase real estate, a whole host of inspections can save you from buying a money pit. With stocks, you can examine some measures of value and the company’s financial condition and business strategy to reduce your chances of buying into an overpriced company or one on the verge of major problems.
Diversify. Placing significant amounts of your capital in one or a handful of securities is risky, particularly if the stocks are in the same industry or closely related industries. To reduce this risk, purchase stocks in a variety of industries and companies within each industry. Even better is buying diversified mutual funds and exchange-traded funds. Diversifying your investments can involve more than just your stock portfolio. You can also hold some real estate investments to diversify your investment portfolio.
If you worry about the health of the U.S. economy, the government, and the dollar, you can reduce your investment risk by investing overseas. Most large U.S. companies do business overseas, so when you invest in larger U.S. company stocks, you get some international investment exposure. You can also invest in international company stocks, ideally through funds. Minimize holdings in costly markets. Although I don’t believe that most investors can time the markets — buy low, sell high — spotting a greatly overpriced market isn’t too difficult.
You should avoid overpriced investments because when they fall, they usually fall farther and faster than more fairly priced investments. Also, you should be able to find other be shunning.
Making sense of returns
Each investment has its own mix of associated risks that you take when you part with your investment dollar and, likewise, offers a different potential rate of return. When you make investments, you have the potential to make money in a variety of ways. To determine how much money you’ve made or lost on your investment, you need to calculate the total return. To come up with this figure, you need to determine how much money you originally invested and then factor in the other components, such as interest, dividends, and appreciation or depreciation.
If you’ve ever had money in a bank account that pays interest, you know that the bank pays you a small amount of interest when you allow it to keep your money. The bank then turns around and lends your money to some other person or organization at a much higher rate of interest. The rate of interest is also known as the yield. So if a bank tells you that its savings account pays 2 percent interest, the bank may also say that the account yields 2 percent. Banks usually quote interest rates or yields on an annual basis. Interest that you receive is one component of the return you receive on your investment. If a bank pays monthly interest, the bank also likely quotes a compounded effective annual yield. After the first month’s interest is credited to your account, that interest starts earning interest as well. So the bank may say that the account pays 1 percent, which compounds to an effective annual yield of 1.02 percent. When you lend your money directly to a company — which is what you do when you invest in a bond that a corporation issues — you also receive interest. Bonds, as well as stocks (which are shares of ownership in a company), fluctuate in market value after they’re issued. When you invest in a company’s stock, you hope that the stock increases (appreciates) in value. Of course, a stock can also decline, or depreciate, in value. This change in market value is part of your return from a stock or bond investment. Stocks can also pay dividends, which are the company’s way of sharing of some of its profits with you as a stockholder and thus are part of your return. Some companies, particularly those that are other income. I discuss the different tax rates that affect your investments and explain how to make tax-wise investment decisions that fit with your overall personal financial situation and goals in Chapter 4.
Where to Invest and Get Advice
Discussing the companies through which you can invest and where to get investing advice may seem out of place to you if you started reading this book from the beginning. But I’m doing this because I strongly believe that you should begin to think about and understand the lay of the land in these important areas so that you can make the best choices.
Selecting the firm or firms through which to do your investing is a hugely important decision. So is the decision about from whom to get or pay for investing advice. In this section, I address both of these topics.
Finding the best fund companies and brokers
Insurance companies, banks, investment brokerage firms, mutual funds — the list of companies that stand ready to help you invest your money is nearly endless. Most people stumble into a relationship with an investment firm. They may choose a company because their employer uses it for company retirement plans or they’ve read about or been recommended to a particular company.
When you invest in certain securities — such as stocks and bonds and exchange-traded funds (ETFs) — and when you want to hold mutual funds from different companies in a single account, you need brokerage services. Brokers execute your trades to buy or sell stocks, bonds, and other securities and enable you to centralize your holdings of mutual funds, ETFs, and other investments. Your broker can also assist you with other services that may interest you.
Deciding which investment company is best for you depends on your needs and wants. In addition to fees, consider how important having a local branch office is to you. If you want to invest in mutual funds, you’ll want to choose a firm that offers access to good funds, including money market funds in which you can deposit money awaiting investment or proceeds from a sale.
For the lowest trading commissions, you generally must place your trades online. But you trading investments too closely, stay away from this form of trading, and use the Internet only to check account information and gather factual information. Increasing numbers of brokers offer account information and trading capabilities via personal digital assistants, which, of course, add to your costs. Digital assistants can also promote addictive investment behaviors.
Among my top investment firm selections are firms that offer mutual funds and ETFs and/or brokerage services.
Broker Phone Number Website
E*Trade 800-387-2331
Muriel Siebert 800-872-0711 Scottrade 800-619-7283
T. Rowe Price 800-638-5660
Vanguard 800-992-8327
TD Ameritrade 800-934-4448
Finding an admirable advisor
I would always counsel folks who took personal finance courses I taught or who contacted me seeking advice to get educated before engaging the services of any financial advisor. How can you possibly evaluate the competence of someone you may hire if you yourself are financially clueless? You’ve got this book, so read it before you consider hiring someone for financial advice. By taking the themes and major concepts of this book to heart, you’ll greatly minimize your chances of making significant investment blunders, including hiring an incompetent or unethical advisor. You might be tempted, for example, to retain the services of an advisor who claims that he and his firm can predict the future economic environment and position your portfolio to take advantage. But you’ll find in reading this book that financial advisors don’t have crystal balls and that you should steer clear of folks who purport to be able jump into and out of investments based upon their forecasts.
Because investment decisions are a critical part of financial planning, take note of the fact that the most-common designations of educational training among professional money managers are MBA (master of business administration) and CFA (chartered financial analyst). Financial planners often have the CFP (certified financial planner) credential, and some tax advisors who work on an hourly basis have the PFS (personal financial specialist) credential.
Advisors who provide investment advice and oversee at least $100 million must register with the U.S. Securities and Exchange Commission (SEC); otherwise, they generally register with the state that they make their principal place of business. They must file Form ADV, otherwise known as the Uniform Application for Investment Adviser Registration. This lengthy document asks investment advisors to provide in a uniform format such details as a breakdown of where their income comes from, their education and employment history, the types of securities the advisory firm recommends, and the advisor’s fee schedule. You can ask the advisor to send you a copy of his Form ADV. You can also find out whether the advisor is registered and whether he has a track record of problems by calling the SEC at 800- 732-0330 or by visiting its website atany states require the registration of financial advisors, so you should also contact the department that oversees advisors in your state. Visit the North American Securities Administrators Association’s website ( ), and click the Contact Your Regulator link on the home page.
Using Investments to Accomplish Your Goals
In This Chapter
Investing for short-term consumption goals Working toward a home purchase Planning for retirement Assessing your desire to take risk
Saving and investing money can make you feel good and in control. Ultimately, most folks are investing money to accomplish particular goals. Saving and investing for a car purchase, expenses for higher education, a home purchase, new furniture, or a vacation are typical short-term goals. You can also invest toward longer-term goals, such as retirement decades in the future. In this chapter, I discuss how you can use investments to accomplish common shorter- and longer- term goals.
Setting and Prioritizing Your Shorter-Term Goals
Unless you earn really big bucks or expect to have a large family inheritance to tap, your personal and financial desires will probably outstrip your resources. Thus, you must prioritize your goals.
One of the biggest mistakes I see people make is rushing into a financial decision without considering what’s really important to them. Because many people get caught up in the responsibilities of their daily lives, they often don’t have time for reflection. Take that time, because people who identify their goals and then work toward them, which often requires changing some habits, are the ones who accomplish their goals. In this section, I discuss common “shorter-term” financial goals — such as establishing an emergency reserve, making major purchases, owning a home, and starting a small business — and how to work toward them. Accomplishing such goals almost always requires saving money. living expenses you should have: Three months’ living expenses: When you’re starting out, this minimalist approach makes sense if your only current source of emergency funds is a high-interest credit card. Longer- term, you could make do with three months’ living expenses if you have other accounts, such as a 401(k), or family members and close friends whom you can tap for a short-term loan. Six months’ living expenses: If you don’t have other places to turn for a loan, or if you have some instability in your employment situation or source of income, you need more of a cushion. Twelve months’ living expenses: Consider this large a stash if your income fluctuates greatly or if your occupation involves a high risk of job loss, finding another job could take you a long time, or you don’t have other places to turn for a loan.
Saving for large purchases
Most people want things — such as furniture, a vacation, or a car — that they don’t have cash on hand to pay for. I strongly advise saving for your larger consumer purchases to avoid paying for them over time with high-interest consumer credit. Don’t take out credit card or auto loans — otherwise known as consumer credit — to make large purchases. (Don’t be duped by a seemingly low interest rate on, for example, a car loan. You could get the car at a lower price if you don’t opt for such a loan.)
Paying for high-interest consumer debt can undermine your ability to save toward your goals and your ability to make major purchases in the future. Don’t deny yourself gratification; just figure out how to delay it. When contemplating the purchase of a consumer item on credit, add up the total interest you’d end up paying on your debt, and call it the price of instant gratification.
Investing for a small business or home
In your early years of saving and investing, deciding whether to save money to buy a home or to put money into a retirement account presents a dilemma. In the long run, owning your own home is usually a wise financial move. On the other hand, saving sooner for retirement makes achieving
You can make penalty-free withdrawals of up to $10,000 from Individual Retirement Accounts (IRAs) toward a first-time home purchase. You might also be able to have the best of both worlds if you work for an employer that allows borrowing against retirement account balances. You can save money in the retirement account and then borrow against it for the down payment on a home. Consider this option with great care, though, because retirement account loans generally must be repaid within a few years or when you quit or lose your job (ask your employer for the details).
When saving money for starting or buying a business, most people encounter the same dilemma they face when deciding to save to buy a house: If you fund your retirement accounts to the exclusion of earmarking money for your small-business dreams, your entrepreneurial aspirations may never become reality. Generally, I advocate hedging your bets by saving money in your tax- sheltered retirement accounts as well as toward your business venture. An investment in your own small business can produce great rewards, so you may feel comfortable focusing your savings on your own business.
Saving for kids’ educational costs
Do you have little ones or plan to have them in your future? You probably know that rearing a child (or two) costs really big bucks. But the biggest expense awaits when they reach young adulthood and want to go to college, so your instincts may be to try to save money to accomplish and afford that goal.
The college financial-aid system effectively penalizes you for saving money outside retirement accounts and penalizes you even more if the money is invested in the child’s name. Wanting to provide for your children’s future is perfectly natural, but doing so before you’ve saved adequately toward your own goals can be a major financial mistake.
This concept may sound selfish, but the reality is that you need to take care of your future first. Take advantage of saving through your tax-sheltered retirement accounts before you set aside money in custodial savings accounts for your kids.
During your younger adult years, you may not be thinking much about retirement, because it seems to be well off in the distance. But if you’d like to scale back on your work schedule someday, partly or completely, you’re best off saving toward that goal as soon as you start drawing a regular paycheck.
In this section, I explain the benefits and possible concerns of investing through so-called retirement accounts. I also lay out the retirement account options you may access.
Understanding retirement account perks
Where possible, try to save and invest in accounts that offer you a tax advantage, which is precisely what retirement accounts offer you. These accounts — known by such enlightening acronyms and names as 401(k), 403(b), SEP-IRA, Keogh, and so on — offer tax breaks to people of all economic means. Consider the following advantages to investing in retirement accounts: